Consultation
Financial Reporting Council
May 2015
Audit Firm Governance Code
A review of its implementation and operation
The FRC is responsible for promoting high quality corporate
governance and reporting to foster investment. We set the UK
Corporate Governance and Stewardship Codes as well as UK
standards for accounting, auditing and actuarial work. We represent
UK interests in international standard-setting. We also monitor
and take action to promote the quality of corporate reporting and
auditing. We operate independent disciplinary arrangements for
accountants and actuaries, and oversee the regulatory activities of
the accountancy and actuarial professional bodies.
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of any person relying on or otherwise using this document or arising from
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Executive Summary
1.
The major accountancy firms are of great importance to the UK economy, both as
major businesses in their own right and through the impact they have on the broader
health of the financial system.
2.
Adoption of the Audit Firm Governance Code (“the Code”) is not a regulatory
requirement, but the firms to which it applies have used it as a catalyst for improved
governance of their businesses.
3.
This report sets out our key findings and goes on to raise a number of questions. Our
principal conclusions are that:

The quality of governance in the major firms is of considerable significance to
investors and to the health of markets.

The firms have taken an important step forward in bringing in Independent NonExecutives. They have brought external challenge into the partnership model.
The firms are in the main well ahead of their international comparators in taking
this step.

However, there is scope for the action already taken to be built upon. The report
suggests that the principle of external challenge be adopted in the international
network organisations as well as at national level. It is also important as the firms
grow their consultancy businesses that this challenge remains focused on the
audit practice as well as across the firm as a whole.

As regards the Code itself we propose that it should more sharply define the
public interest, particularly by explicitly recognising the importance of audit
quality.

The Code should continue to be sufficiently flexible to allow firms to apply it in
ways which best suit their governance structure.
Introduction
4.
The Code was introduced in January 2010. It applies to firms auditing 20 or more listed
companies.
5.
At the time of its introduction it was recommended that the implementation of the Code
be reviewed after four years by the FRC. This report constitutes the first stage of that
review. It describes how the Code has been implemented by the firms and discusses
the wider context in which the Code operates. It goes on to detail the feedback we
have received so far and concludes with a consultation on possible changes to the
Code.
Financial Reporting Council 1
6.
We have so far spoken with investor groups; with the ICAEW; with the chair of the
original working group; and a number of Audit Committee Chairmen. We have also
interviewed Independent Non-Executives and members of senior management from all
seven firms to which the Code is currently applicable. We would like to thank everyone
for their contributions to our review. However, we are conscious that so far our
preliminary analysis relies on feedback from a relatively small group of stakeholders
and we are interested in views from as many users of audit services and others as
possible. Interested parties are invited to send any feedback to [email protected]
by 28 August 2015.
Development of the Code
7.
In the wake of the collapse of Arthur Andersen, concerns arose about the preservation
of an adequate supply of high quality audits in a highly concentrated market. A Market
Participants Group (MPG) was formed to suggest market-based solutions.
8.
One of its recommendations was for major audit firms to follow a UK Corporate
Governance-style Code. The resulting Audit Firm Governance Code, was created with
the aim of:
“Provid[ing] a formal benchmark of good governance practice against which firms which
audit listed companies can report for the benefit of shareholders in such companies.”
9.
Its specific intended benefits were to:






Support firms in their objectives of performing high quality audit work that gives
confidence to shareholders.
Benefit capital markets by enhancing choice and helping to reduce the risk of a firm
exiting the market.
Enhance the stature of firms as highly visible exemplars of best practice governance
Enrich firms’ transparency reports.
Encourage changes in governance which improve the way that firms are run.
Strengthen the regulatory regime by achieving transparency and effective
governance without disproportionate regulation.
10.
It was also thought that the Code would help firms adjust to developments such as
regulatory change, falling trust in the profession, technical change and change in firm
structures that were happening at the time and continue today.
11.
The Code is principles-based, and those firms adopting it are expected to follow these
principles. Compliance with each of the Code’s individual provisions is on a “comply or
explain” basis. To deliver the expected benefits it includes provisions on governance
and transparency under six headings:

1
Leadership – The management of a firm should be accountable to the firm’s
owners1 and no individual should have unfettered powers of decision.
Usually its partners
2 Audit Firm Governance Code: A review of its implementation and operation (May 2015)





12.
At the time of its introduction the Code applied to eight audit firms:








13.
Values – A firm should perform quality work by exercising judgement and
upholding values of integrity and objectivity in a way that takes the public
interest into consideration.
Independent Non-Executives – INEs should be appointed to provide an
external voice in the firms to enhance commitment to the public interest in the
firm’s governance and decision making.
Operations – Firms should provide for good quality regulatory compliance, risk
management, people management and whistleblowing procedures.
Reporting – Good quality public reporting by the firm is encouraged.
Dialogue – Firms should reach out to listed company shareholders as well as
the management of the companies and their audit committees.
Baker Tilly
BDO
Deloitte
EY
Grant Thornton
KPMG
PKF
PricewaterhouseCoopers
BDO and PKF have since merged, leaving seven firms within the scope of the Code.
In addition a further firm, Mazars, has adopted the Code.
Link to the Corporate Governance Code
14.
In drafting the Code, the original Working Group had regard to the existing principles of
the Corporate Governance Code and designed it around a similar structure. Whilst
partnerships differ from listed companies and aspects of the Corporate Governance
Code are not applicable, there are many provisions in the Corporate Governance
Code which can easily be applied to many types of organisation. We discuss later in
this report some aspects of the Corporate Governance Code which might translate
effectively to audit firms.
Purpose and the Public Interest
15.
As part of this review the FRC seeks views on whether the purpose of the Code and
the intended benefits remain valid. The Code establishes its principal purpose as
working for the benefit of shareholders in listed companies. The FRC supports this.
However, the Code also refers to the protection of the public interest in setting out the
role of the INEs. It does so without being clear what the public interest is and whether
it is synonymous with the shareholder interest. INEs and others have therefore sought
clarity on how the public interest is defined, seeking to ensure the Code guides firms
and INEs appropriately in their work in the public interest. This lack of clarity should be
addressed.
Financial Reporting Council 3
16.
The FRC proposes that the purpose of the Code should lie primarily in the promotion
of high quality statutory audit in the interests of shareholders and in accordance with
law and regulation. A quality audit is one that provides a high level of assurance that
the financial statements comply with the law and financial reporting requirements or
one that gives rise to an auditor’s report that communicates the auditor’s disagreement
or restricted ability to opine. A high quality audit also complies with applicable laws,
regulations and professional standards. Some of these professional standards, notably
those relating to independence, are unique to audit. In considering the public interest
firms should also be mindful of the societal value of audit.
17.
The public interest also arises in other types of regulated work undertaken by the
firms, for example insolvency, investment business and non-audit work which is
required by law or regulation to be conducted by the auditor. Those charged with
governance should have effective oversight over those parts of the business.
18.
The Code should also promote good quality, soundly managed work outside of
statutory regulation. This should be undertaken in such a way as to avoid undermining
public confidence in the firm and hence in its audit work.
19.
We welcome views on the above expression of the public interest in this context and
whether it should be put into the Code. We recognise that defining the public interest is
fraught with difficulty, and that there is a multiplicity of views as to its meaning. We also
note that the question of public interest is being discussed in other fora, for example in
relation to the development of Ethical Standards. We may not therefore reach a final
answer through this consultation.
20.
In considering wording on the public interest it also should be recognised that the spirit
with which the public interest is pursued is as important as the definition. A legalistic
and minimalist approach may preserve a firm from regulatory or legal challenge but will
not build public confidence.
How the Code has been applied
21.
Many of the Code’s provisions were already in place when it was introduced. Major
audit firms had arrangements covering such matters as leadership, risk management,
people development and an internal Code of Conduct.
22.
The most significant changes the Code introduced were the provisions on:


23.
The appointment of INEs;
Dialogue between audit firms and shareholders in listed companies.
Details of how each firm has implemented and reported on the Code can be found in
the Appendix. Overall there are many similarities in the approach that each firm has
taken but also some important differences, notably in respect of the positioning of INEs
within the governance structure. This positioning often relates to each firm’s broader
governance structure and the respective responsibilities and accountabilities of the
core executive management team and its oversight body, which is typically elected
directly by the partnership.
4 Audit Firm Governance Code: A review of its implementation and operation (May 2015)
24.
There are two basic models:


INEs sit on the Board or a similar governing body.
INEs sit on a separate public interest committee.
25.
EY, due to its global governance structure, has a different approach involving the
appointment of INEs at regional level and a global public interest committee.
26.
In their transparency reports, almost all of the firms report on their attempts to engage
in dialogue with shareholders in listed companies, making references to individual
meetings with investors on particular matters; to stakeholder forums; and to informal
discussions with institutional investors and others.
27.
We understand from firms and investors, however, that these attempts at engagement
have not always been successful and that the investor audience for such meetings is
limited.
Has the Code achieved its purpose?
28.
As noted above the Code sought to provide a formal benchmark of good governance
practice against which firms which audit listed companies can report for the benefit of
shareholders in such companies.
29.
Underneath this purpose lay a number of objectives which fell into four broad
categories:



30.
Improving firms’ governance in order to support the provision of high quality work to
give confidence to shareholders and improve the way they are run.
Increasing competition and choice in the audit market and helping to reduce the risk
of a firm exiting the market.
Enhancing firms’ reporting and transparency more broadly and enhancing their
stature as visible examples of best practice.
We are keen to seek views on the extent to which the Code has achieved its stated
purpose and delivered the above hoped-for benefits. Our preliminary views are as
follows.
Governance
31.
The firms have clearly enhanced governance in recent years through the involvement
of INEs, the creation of public interest committees and the development of other
checks and balances on the way management runs the business. Internal processes
for ensuring audit quality have improved at the same time and overall the FRC’s
inspections have shown the quality of individual audits has also improved. It is not
possible to say how much of this is due to the Code, not least because of the extent of
regulatory change that has occurred in parallel, but it is reasonable to conclude the
impact has been beneficial. In particular, the widespread appointment of INEs and
their active involvement in discussion and, in some cases decision-taking, at the
highest levels is to be welcomed. Partnerships have many strengths but they can also
Financial Reporting Council 5
be introspective compared to a public company and so the fresh insight and challenge
of external non executives is important.
32.
There are, however, important aspects of the governance of the firms that warrant
further consideration.
33.
The role of the INEs certainly needs to be better understood by stakeholders. They are
not directors comparable to NEDs on a public company unitary board. Nor do they
share the rights and powers of partners. They are influential, often powerfully so, but
are not capable of pushing through decisions. Investors must not be allowed to
misunderstand their authority.
34.
Similarly there is confusion about the INEs’ purpose and to whom they are
accountable. This needs to be clarified. We believe their role is to promote the public
interest – hence, our focus on defining the public interest more clearly as proposed
above.
35.
Currently, the Code states that INEs’ duty of care is to the firm. Some have suggested
this is incompatible with the public interest. Others have suggested INEs should also
be accountable to shareholders or to the FRC. We welcome the dialogue INEs have
with the FRC. But that does not make them formally accountable to the FRC. We do
not appoint them or approve their appointment. Nor can they be appointed by
shareholders of audit clients. However, even if formal accountability outside the firm is
not possible we believe boards, public interest committees and INEs should regard
themselves as being accountable to the public and conduct themselves accordingly.
That means ensuring there is high quality public transparency of their role and work so
that they can be questioned and challenged and that if there is evidence of public
disquiet they should respond to this. We welcome views on this.
36.
As noted above the firms have adopted different public interest / governance
structures in response to the Code, reflecting different organisational models. These
are also permitted by the comply or explain basis of the Code. The FRC does not
believe the Code should be prescriptive. However, the firms will not meet the Code’s
objective of creating investor confidence in governance unless they explain well why
their model has been chosen and why it makes more sense for their firm than the
alternatives. The firms have given the FRC strong arguments as to why they have
adopted particular models but at present their public explanations are somewhat
limited in this regard.
37.
There are also certain features of governance that the FRC would wish to see in any
structure. These concern governance at an international level and a high degree of
focus on audit.
38.
The major firms in the UK are entities within international networks. These networks
enhance the firms’ ability to work together with overseas partners to audit multinational
business to a consistent standard. The network organisations have considerable
influence over how the firms are run and have the ultimate sanction of removing a
firm’s brand. They exist both to raise standards and to protect national firms from
contagion from litigation elsewhere in their world. Some investors therefore see their
6 Audit Firm Governance Code: A review of its implementation and operation (May 2015)
role as ambiguous. Whether or not that is true they are certainly powerful and, as the
firms globalise, will become more so.
39.
Although there are a number of international bodies which are influential in standard
setting and sharing national best practice in this area, the regulation of statutory audit
itself remains on a national level. The network entities conduct no audit work
themselves and hence are not subject to direct regulation. Nor have they generally
developed governance structures of the kind envisaged in the Code, including INEs.
The FRC therefore believes that it is imperative that the network organisations review
whether their governance is fit for purpose and whether they should adopt some
provisions of the Code. We are raising this with the network firms.
40.
We do not, however, wish any such review to lead to a reduction of the quality of
governance at national level. Audit will continue to be led and executed by national
firms under national law and regulation. We strongly believe that even if greater
globalisation takes place firms should ensure there is at national level a governance
structure that can protect and account for both the performance of the firm as a whole
and the performance of the audit division in relation to the protection of the public
interest. To that end, we believe the firms should consider creating specific
governance structures for their audit (and, perhaps, assurance) practices. Such
structures should be in addition to the wider governance of the firm and should not
replace it; for example, we believe that INEs should sit at the firm level as well as
being part of audit-specific arrangements.
41.
The FRC maintains a close dialogue with the management of each firm at senior
partner and regulatory partner level covering the results of inspections and risk to the
public interest. As noted above, we also meet INEs. We propose that in future the FRC
should hold regular meetings with each firm’s Board and public interest committee in
addition to its ad hoc meetings with senior partners.
Increasing choice and reducing the risk of a firm exiting the market
42.
A key driver in the development of the Code was concern about choice in the audit
market and, post-Andersen, the risk of another audit firm failure. It was hoped that the
existence of a governance code for major audit firms would help give large companies
the confidence to consider a wider range of potential auditors and hence mitigate the
concentration seen in this market2.
43.
There is no indication, however, that the existence of the Code has had an impact on
concentration in the audit market. Non-Big Four firms have not to date increased their
market share within the FTSE 350.
44.
Since the issue of the Code, the Competition and Markets Authority (CMA; formerly
the Competition Commission) has conducted an investigation into the audit market for
2
Over 90% of FTSE 350 audits are conducted by the “Big Four” audit firms (Deloitte, EY, KPMG and PwC).
Financial Reporting Council 7
large companies and has proposed a number of remedies to address what it found to
be adverse effects on competition. In its report the CMA made only a passing mention
of the Code and it did not feature in any of the remedies.
45.
Whilst there is little evidence that the existence of the Code has affected the structure
of the audit market, improved governance structures may reduce the risk of a firm
failing. Management and INEs should be better placed to identify potential issues
before they become life-threatening. In addition, in the event that a crisis did occur, the
presence of INEs provides regulators and others with a route to engage with the firms
at a senior level in the event of a concern about the quality or integrity of a firm’s
executive management.
46.
Firms are already required, under the statutory requirements for transparency
reporting, to provide a description of their internal quality control system and a
statement on the effectiveness of its functioning. We believe that the effectiveness of
internal control requires strong leadership focus and that there is a case for the Code
to be more specific about best practice and reporting in this area as in the guidance
sitting alongside the Corporate Governance Code. Specifically we believe the firms
should give clear assurances that they have addressed risk and make a longer term
viability statement as now required of listed companies.
Transparency reporting
47.
The Code states that firms should report on their compliance with it, or explain their
non-compliance, in their transparency reports. Transparency reporting came into force
in the UK in 2010, via a Statutory Instrument implementing one aspect of the Statutory
Audit Directive.
48.
Transparency reports are mandatory for all firms which audit one or more listed
companies. This is a much wider population than is affected by the Code; around forty
UK firms in total are required to produce transparency reports.
The FRC has previously reported on the quality of transparency reporting3. Those
firms which apply the Code include additional disclosures on their compliance with it
and several provide a reconciliation of these disclosures against each of the relevant
Code provisions. Most also include a separate report from the INEs and/or the firm’s
public interest committee. Despite this we are not convinced that transparency
reporting is drawing wider attention to the firms’ governance arrangements.
3
https://www.frc.org.uk/Our-Work/Publications/Professional-Oversight/Transparency-Reporting-by-Auditors-of-
Public-Inter.pdf
8 Audit Firm Governance Code: A review of its implementation and operation (May 2015)
49.
Details of the firms’ most recent disclosures on their implementation of the Code are
given in the Appendix. In general terms we found that the firms provided detailed and
informative disclosures around Leadership, Values, INEs and Dialogue and that these
disclosures were often framed in the context of the Code.
50.
Disclosures around the Operations and Reporting principles were also detailed, but
were sometimes less easy to locate and often did not make direct reference to the
Code.
51.
Most of the stakeholders we have spoken to felt that there was useful information in
the transparency reports but also a lot of boilerplate and that they had become dull
compliance documents which were not widely read. Some blamed the Statutory
Instrument, arguing that its provisions encouraged tick-box compliance-focused
reporting. Others pointed to internal templates set at network level which are required
to be followed and which leave little room for national firms to develop their own
reporting.
52.
It is important to note that the requirements of the Statutory Instrument are intended to
provide the minimum criteria on which firms should report. There is nothing to prevent
firms from providing additional information and indeed we would encourage firms to do
so.
53.
A number of stakeholders suggested that the FRC could invigorate reporting and
increase the visibility of the Code by highlighting particular disclosures by firms in our
own publications. We will consider how we can best do so without turning the Code
into a “comply” rather than comply or explain document.
Specific Questions
54.
In the light of the above a number of questions are set out below on which we would
welcome views.
Purpose
55.
Firstly, and most importantly, is the stated purpose of the Code still valid?
56.
The Code’s objectives are wide. Some of them, particularly around competition, may
be beyond the scope of a governance code. It is also clear that some aspects, notably
the interaction between firms and investors, have been less successful than was
hoped
57.
Feedback from stakeholders highlighted the following:

The public interest must be central to the Code and the work of the INEs. Any
changes to the Code should reinforce this.

The role of the INEs was seen as very important but there was a lack of clarity as to
what this role should actually involve. A number of INEs noted that they had been
Financial Reporting Council 9
unclear as to their responsibilities when appointed and that it took some time to “find
their feet” and grow into the role. There appears to be an appetite among INEs,
firms’ management and in particular investors for greater clarity on the purpose of
the Code and the role of the INEs in particular. The existing purpose may be too
broadly stated. This is tempered by some reluctance on the part of the firms and
INEs to have their role too tightly prescribed by the FRC.

58.
59.
Investors are clear that they want the Code and INEs to focus on audit quality, and
to reinforce the importance of independence and professional scepticism.
Based on our own observations and the feedback we have received we believe that
the public interest in this context rests in:

Firstly, and of greatest importance, audit quality.

Secondly, the firm’s reputation more broadly; this involves oversight of the firm’s
non-audit businesses. These now make up 70 - 80% of the major firms’ revenues.
Some of these businesses are subject to statutory regulation but the majority are
not.

Finally, prevention of a firm failure.
In our view the purpose of the Code should be restated in order to reflect this.
Do you agree that the Code’s purpose should be redefined in this way?
Safeguarding audit quality
60.
There is a public interest in many of the services provided by the audit firms as well as
in the firms themselves; they are major employers and contribute significantly to the
UK economy. However, the public interest arises most acutely in their audit work.
61.
Audit, as a mature market, has remained a relatively stable source of firms’ revenue
for many years. That contrasts with the high growth rate in many firms’ consultancy
practices. In some firms less than a quarter of their revenue is now derived from audit.
This has led to some concern amongst regulators, INEs and investors alike about the
impact on the firms’ culture and future strategy; concern which has been heightened
by the acquisition of consulting businesses by some audit firms. The management of
the firms continue to state the importance of audit to their business but there is a
question as to how long this can continue given the growth in consultancy work.
62.
Some INEs compared the culture of the consultancy businesses in the firm negatively
with that of the audit practice and others queried how long the firm could survive in its
current form without splitting into two. Audit quality depends on the firm promoting
integrity, scepticism and independence from clients. These values do not apply to the
same degree to consultancy work.
63.
One way of safeguarding audit quality, the culture associated with the audit practice
and the importance of audit within the wider business might be to ring fence the audit
10 Audit Firm Governance Code: A review of its implementation and operation (May 2015)
practice to some extent. This could include the creation of separate audit-only
governance structures that are specific to audit and the introduction of specific
responsibilities for INEs in relation to audit quality.
64.
Firms and INEs were sceptical of this suggestion, arguing that in order to preserve and
enhance audit quality, INEs should actually focus on the firm as a whole. This is
because as a threat to the reputation of audit business is more likely to arise outside of
audit where some work (eg corporate finance) is inherently risky. Concerns were also
raised that separating governance arrangements in this way risked encouraging the
separation of the audit business’s culture and that of the consultancy practice. Further,
if INEs found their role limited to oversight of the audit practice, there is a risk that
public interest matters arising outside of that area will not come to their attention.
65.
It was noted that the direction of travel elsewhere, eg in banking, has been to work to
embed a single ethical culture throughout the organisation and that this may be more
difficult if different governance arrangements apply to audit.
Should there be separate governance arrangements for audit? What might such
arrangements look like?
66.
Regardless of the precise nature of the governance arrangements in place, if audit
quality is to be safeguarded there needs to be an appropriate “tone at the top” and a
strong culture of ethics and professionalism in place. There is evidence from AQR
inspections that firms can have a strong tone at the top and high quality processes but
that these do not always translate to the work being done on every engagement or to
the behaviour of individual partners and staff.
67.
The importance of the “tone at the top” and the responsibilities in this regard of the
leadership of audit firms are reflected in the FRC’s Ethical Standards for auditors. The
FRC is currently reviewing these standards and considering how the ethical principles
set out within them can be reinforced and clarified. This includes the responsibility of
the senior management of the firm to instil the necessary culture and behaviours
throughout the firm so as to ensure that compliance with the ethical principles is
paramount and the public interest supersedes all commercial interests of the firm.
Proposed changes to these standards will be consulted on in due course.
68.
We believe that the Code could also be used to help embed firms’ tone at the top and
push this tone further down the organisation. The Code already makes reference to
the importance of tone at the top but it should be possible to enhance this section,
perhaps by including specific requirements for firms to report in more detail on how this
is cascaded throughout the organisation.
Should the Code include more detail and impose more requirements on tone at the top
and professionalism more generally?
International context
Financial Reporting Council 11
69.
All of the major audit firms are part of international networks and the UK national firms
have varying degrees of autonomy within each of the global structures.
70.
As noted above only a handful of other jurisdictions have introduced similar
governance requirements for audit firms. We believe that there is considerable merit in
other major territories introducing their own governance arrangements, and also for
aspects of the Code to be picked up at network level. However, we recognise that
there are challenges in doing so.
Do you agree that the concept of the Code should be spread elsewhere in the world?
How might this be achieved?
71.
In the case of some firms, notably EY, the UK partnership has limited ability to
influence the future direction of the firm, with most strategic decisions being taken at a
regional or global level. At the same time the regulation of audit and auditors is the
responsibility of national authorities.
72.
In the case of EY INEs are appointed at a global level and only one is UK-based.
Mazars, which applies the Code voluntarily, has appointed INEs at a European level
and neither of them is UK-based.
73.
We have no criticism of current INEs but we do see risks in having decision-making
and governance arrangements for UK-based firms conducting UK statutory audits
taking place overseas. We will give further thought to this issue in the coming months.
Role of the INEs
74.
INEs, even if they sit on the management board, are not direct equivalents of NEDs at
a corporate. Their public interest responsibilities are unique in this context.
75.
Given that INEs do not correspond exactly to NEDs, “Independent Non-Executive”
may not be the right term. Corporates often have advisory boards comprised of
external individuals who provide advice to the board as well as fulfilling an
ambassadorial role. We considered whether INEs, particularly those who do not sit on
the firm’s main Board, were similar to advisory board members, but what makes INEs
unique is their public interest responsibility.
76.
Investors stressed the importance of INEs being, and being seen to be, independent.
The existing Code notes the need for any firm which applies it to address two
independence issues:


77.
The relationship between the INE and an entity audited by the firm
The relationship between the INE and the firm itself and/or its owners (ie its partners)
We found that firms and INEs took independence seriously and, where a potential
independence issue arose, would take steps to ensure that appropriate safeguards
were in place. However a small number of situations which are not directly addressed
by the Code currently have arisen, for example:
12 Audit Firm Governance Code: A review of its implementation and operation (May 2015)


A firm appointed a serving partner as an INE. This is not explicitly addressed by the
Code although it does note the need for careful consideration if the appointment of a
former partner is being considered.
A firm tendered for the audit of a listed company of which one of its INEs also served
as a NED. The INE took no part in the selection of the audit firm and resigned from
the INE position when the firm was appointed.
78.
We believe that the Code should be amended to address these situations and will
address these specific issues in a future draft.
79.
If INEs are to enhance public and shareholder confidence in their audit firms, their
independence needs to be considered more broadly. It is important that they are not
seen to act as advocates for the firms rather than as guardians of the public interest. In
this context we would also note that there is a view that the wider partnership acts as a
check on the executive leadership taking a wrong turn, and therefore INEs’ interaction
with the firm’s partners as a whole should not be neglected. This interaction can help
to safeguard the public interest.
80.
One area where we believe there may be room for improvement is in the appointment
process for INEs. Most are currently appointed by the firm’s executive management,
perhaps with the assistance of recruitment consultants, and their appointment may, or
may not, be approved by the wider partnership. Investors have indicated that they
would like to have some input into the appointment process although the precise
mechanics of any such input remain unclear and may be difficult to achieve in practice.
Firms could, however, consider discussing with investors their approach to the
appointment process and the key attributes they are looking for in new INEs.
How might the independence of INEs be protected and demonstrated?
Should the firms follow a standard process in appointing INEs, including all such
positions being publicly advertised? What engagement, if any, should investors in
audited entities have into an audit firm’s appointment of INEs?
Should the FRC or any other regulator have a role in the appointment of INEs; perhaps
a right of veto?
81.
The provisions of the Code differ from and are in most respects less demanding than
those of the Corporate Governance Code. We believe it would not be appropriate to
import the Corporate Governance Code wholesale to audit firms because the risks and
governance issues affecting owner-managed businesses are quite different to those
which have large numbers of external shareholders.
Financial Reporting Council 13
82.
That said there are aspects of the Corporate Governance Code and of corporate
governance good practice more broadly which, given the significance of the audit firms
to the markets, which may if applied enhance confidence in the Code, and in the role
of INEs. For example:








The inclusion in firms’ transparency reports of a viability statement providing an
assessment of long term solvency and liquidity
Term limits on INEs’ appointment
Transparency around the remuneration of INEs
A minimum number of INEs per firm
A requirement for at least one INE to have recent and relevant financial experience
An independent Chairman
Greater consideration of diversity
A formal role for INEs on remuneration, nomination, risk and/or audit committees
Which of these, if any, should be incorporated into the Code? Are there any other
aspects of the Corporate Governance Code which should also be considered?
Accountability
83.
The question of accountability, particularly in the context of INEs, was raised on a
number of occasions. If INEs were the direct equivalents of NEDs at a corporate then
their role would be to represent, and be accountable to, the owners of the business ie
the wider partnership. However INEs, even if they sit on the management board, are
not the direct equivalents of NEDs. In particular, there is a lack of clarity as to whom
INEs are accountable. The Code states that the INEs’ duty of care is to the firm and
yet their responsibility is to the public interest. One INE indicated that he saw his line of
accountability as being to the regulator.
84.
As the UK’s lead audit regulator we meet directly with INEs both collectively and
individually. We find this valuable and feedback from INEs indicates that they also
welcome this direct dialogue with us. However the Code does not currently require
INEs to engage directly with the FRC or to “whistleblow” to us or other regulators. We
welcome views on the extent to which such a duty might be reflected in the Code.
85.
One way to encourage accountability is through greater transparency. Despite some of
the negative feedback we have received about transparency reports, including their
limited audience, we believe that there are ways in which reporting in this way can
drive accountability.
86.
Transparency reports could be enhanced by the inclusion of success measures or key
performance indicators of some sort and a report of the firm’s performance against
them. It has also been suggested that INEs should report specifically on what they
have done during the year to discharge their public interest responsibilities. This might
be via the transparency report or in a separate letter to the FRC which we would
publish.
14 Audit Firm Governance Code: A review of its implementation and operation (May 2015)
87.
The firm’s management might also be asked to confirm that in their opinion the
Transparency Report is “fair, balanced and understandable” similarly to governance
reporting by listed companies.
88.
As noted above transparency reports could include of a viability statement concerning
the firm’s long-term liquidity and solvency. The statement could be made jointly by
management and INEs.
To who should the boards, INEs and public interest committees be accountable? How
should this accountability be discharged, including to the FRC?
Should the Code include specific provisions on the firms’ Boards and Public Interest
bodies engaging with and disclosing certain matters to regulators?
Is greater transparency sufficient? What else can be done?
Other issues
89.
Currently the Code was created for firms which audit more than 20 listed companies
and has been adopted by the seven largest audit firms plus one other. There are
around 40 other firms which audit listed companies.
90.
Increasing the reach of the Code to a wider group of firms may help to raise
confidence in the profession as a whole, but we are also conscious of the need to
ensure that regulation is applied in a proportionate manner.
Should the Code be applied to a wider group of firms?
91.
The Code was published jointly by the ICAEW and FRC following extensive work by
the ICAEW and others. The feedback we have received to date is that the Code
should now be owned by the FRC as the independent regulator and inspector of the
firms which apply it, with input from the ICAEW and other professional bodies as
required. The FRC will also continue to act as a convenor of meetings with INEs and
to meet with INEs individually about matters of concern.
Do you have any comments on the role of the FRC in this context?
Do you have any further comments on any of the issues raised in this report?
Financial Reporting Council 15
APPENDIX – IMPLEMENTATION OF THE CODE BY FIRM
Leadership
Values
INEs
Baker
Tilly
Baker Tilly in the UK is
made up of a number of
limited liability
partnerships. The audit
business is contained
within Baker Tilly UK
Audit LLP.
The main governance
body for Baker Tilly UK
Audit LLP is the
Management Board.
The Board is elected by
the members of the LLP
from candidates
approved by the Baker
Tilly UK Group.
Day to day
management of Baker
Tilly UK Audit LLP is
done by the Audit
Management Team
On its website Baker
Tilly details its five
core values. It also
links to its Code of
Business Conduct
Baker Tilly’s two INEs sit on
a Public Interest Committee
along the with firm’s Ethics
Partner.
This is a relatively new
arrangement; for the first
three years of operation
Baker Tilly’s INEs (which at
the time included the current
Ethics Partner) sat on the
Management Board of Baker
Tilly UK Audit LLP.
Describing the Ethics Partner
as an INE was criticised by
the AQR and following this,
Baker Tilly changed its
approach.
Although the INEs no longer
sit on the Management
Board they do attend
meetings where they will
contribute to the discussion
of ethical/risk/quality issues
but do not take part in the
decision-making.
16 Audit Firm Governance Code: A review of its implementation and operation (May 2015)
Operations
Reporting
Dialogue
The firm’s transparency
report addresses the
matters listed under the
Operations principle
although they are not
described in those terms
The firm’s public
reporting covers
the Code’s
Reporting
principles although
it does not provide
a specific
statement on the
firm’s compliance
or otherwise with
the Code’s
provisions,
although there is a
statement
concerning the
PIC’s commitment
to the Code
In its 2014
transparency report
Baker Tilly UK Audit
LLP lists engagement
with external
stakeholders, including
shareholders, as being
amongst the duties of
the INEs
BDO
Leadership
Values
INEs
Operations
Reporting
Dialogue
BDO’s Leadership
Team functions as the
main Board of the firm.
The Leadership Team is
appointed by the
Managing Partner and
approved by the
Partnership Council. It
comprises seven
executives as well as
BDO’s two INEs.
In its transparency
report BDO lists its
core values in the
context of the culture
of the firm. The firm
makes reference to
an internal code of
conduct, the whole
of which does not
appear to be on its
website, although
there is a page
discussing the
values in more
detail.
BDO was the first firm to
appoint INEs, doing so in
2008 (ie two years before the
Code was published).
Currently there are two INEs,
both of whom sit on the
Leadership Team.
BDO’s transparency
report covers the relevant
issues under the Code’s
Operations principle
BDO’s public
reporting covers
the Code’s
Reporting
principles
The firm reports that
its representatives
have met informally
with listed companies
and their shareholders.
Partners have also
met with institutional
shareholders in an
attempt to understand
their needs
Oversight of
management is
provided by the
Partnership Council,
which comprises twelve
elected partners plus
the Senior and
Managing Partners and
two representatives
from the Leadership
Team, who may attend
at the invitation of the
Managing Partner.
INEs also sit on BDO’s
Public Interest Committee,
together with the firm’s
Ethics Partner.
One of the INEs sits on the
firm’s Risk & Quality
Committee.
BDO also has a Public
Interest Committee
(PIC), consisting of the
INEs and the Ethics
Partner. The role of the
PIC is to consider public
interest matters which
Financial Reporting Council 17
Leadership
Values
INEs
Operations
Reporting
Dialogue
In its transparency
report Deloitte refers
to the values of
“integrity, respect,
fairness, objectivity
and accountability”.
Deloitte’s “Ethics
Code” is available
on its website
Deloitte’s INEs all sit on the
Board of Partners. Through
their role on the Board of
Partners the INEs are
involved with all aspects of
the firm’s management and
governance. An INE attends
every audit committee
meeting and an INE sits on
the Board subcommittee
which considers FRC and
PCAOB reports on the firm.
Deloitte’s transparency
report covers its
arrangements, policies
and procedures for each
of the provisions of the
Operations part of the
Code.
Deloitte’s public
reporting covers
the majority of the
Code’s Reporting
principles although
its 2014
transparency
report did not
provide a specific
statement on its
compliance or
otherwise with
each of the
provisions of the
Code
Over the past few
years Deloitte has
organised stakeholder
forums to discuss audit
quality and
governance and
regulatory issues. The
firm also reports
separate discussions
with “key investors”
and other market
participants
affect the firm and
enhance stakeholder
confidence in the public
interest aspects of the
firm’s activities
Deloitte
Deloitte’s primary
governance body is the
Board of Partners,
which determines the
firm’s strategy, provides
oversight of
management and
protects partners’
interest. The Chairman,
CEO, INEs and eleven
elected partners all sit
on the Board of
Partners.
Implementation of the
firm’s strategy and
policy, and its day to
day management, is the
responsibility of the
Executive Group
In addition to their role on the
Board of Partners, the INEs
also form a separate Public
Interest Oversight Board
which considers governance
and ethical issues and forms
a channel for communication
with external stakeholders.
One of Deloitte’s three INEs
has now stepped down; a
replacement will be
appointed
18 Audit Firm Governance Code: A review of its implementation and operation (May 2015)
EY
Leadership
Values
INEs
Operations
Reporting
Dialogue
EY in the UK is
controlled by EY
Europe. A UK Board
remains and has
authority for operational
management in the UK.
It is appointed by the
Europe Executive
(effectively the EY
Europe Board).
EY’s transparency
report discusses its
three core values
and its Global Code
of Conduct, which is
available on its
website
EY has appointed INEs on a
global basis, with four
(formerly five) nonexecutives from across the
world sitting on the GAC.
EY’s transparency report
covers the topics set out
under the Operations
principles, although it is
not structured in this way
EY’s public
reporting covers
the majority of the
Code’s Reporting
principles although
its application of
the internal
reporting principle
is not explicit. Its
2014 transparency
report does not
provide a specific
statement on its
compliance with
each of the
provisions of the
Code.
EY reports meeting
regularly with
stakeholders, including
investors. In its
transparency report
specific examples of
investor engagement
are given
The firm’s transparency
report sets out the details
of its policies and
procedures under each of
the Operations principles.
The 2014
transparency
report appears to
cover the
provisions under
the Code’s
Grant Thornton reports
that its Head of
External Professional
Affairs chairs a global
body consisting of
investor and auditor
One of the INEs is UK-based
and it is him who will engage
with the FRC on audit-related
matters
EY globally recently
established a Governance
Working Group and one
recommendation from the
Group was to set up a
separate Public Interest SubCommittee on which all INEs
will sit
The Europe Executive
is advised by the
Europe Advisory
Council, which is
elected by partners
within the European
region
Co-ordination of EY’s
global strategy is done
at network level by EY
Global. There is exists a
Global Executive and a
Global Advisory Council
(GAC)
Grant
Thornton
Grant Thornton’s
principal leadership and
governance bodies are
the National Leadership
Board (NLB), which is
an executive body
Grant Thornton’s
values are described
in the terms of its
Code of Conduct –
this can be found on
Grant Thornton has three
INEs. They sit on the firm’s
POB and least one INE sits
on all POB standing and ad
hoc subcommittees.
Financial Reporting Council 19
KPMG
Leadership
Values
INEs
charged with developing
and implementing the
firm’s strategy; and the
Partnership Oversight
Board (POB) which
oversees the NLB and
protects the interests of
the partners. The POB
consists of eight
members elected from
the partners, three INEs
and three ex officio
members
the website
All of the INEs sit on Grant
Thornton’s newly constituted
profit share committee. This
does not judge the quantum
of an individual partner’s
profit share but does look at
the process and queries any
outliers.
The main governance
body for KPMG in the
UK is its Board. The
Board consists of the
Senior Partner, the
Chief Operating Officer
/Head of People, the
Head of Quality & Risk
Management and six
Non-Executive
members. “NonExecutive” in this
context means partners
in the firm who are not
part of the executive
management of the
firm.
KPMG has a Code
of Conduct which is
disclosed on its
website. The Code
of Conduct sets out
KPMG’s Values and
the “standards of
ethical conduct”
expected from
partners and staff.
KPMG has recently changed
its European structure in
favour of national firms and
has appointed three new
INEs as a result. One INE
from the previous structure
remains.
The firm’s 2014
transparency report
also discusses the
importance of “Tone
at the Top” in
providing a focus on
quality
The INEs do not sit on the
Board but instead form a
separate Public Interest
Committee (PIC). One of the
INEs will however usually
attend the firm’s monthly
Board meetings and there
are joint Board/PIC strategy
sessions.
20 Audit Firm Governance Code: A review of its implementation and operation (May 2015)
Operations
In its 2014 transparency
report KPMG sets out in
some detail its key
operational arrangements
and relevant policies and
procedures. The Board
confirms that the firm has
complied with the
provisions of the Code
Reporting
Dialogue
Reporting
principle, although
they are not
described in those
terms. The key
which maps the
Code to the
transparency
report does not
include anything
under this section
representatives. In
addition, one of the
firm’s INEs meets
periodically with
representatives of
major UK institutional
shareholders
KPMG publishes
its financial
statements in its
annual report. All
other external
disclosures
referenced under
the Reporting
principle are made
in the annual
report or the
transparency
report. The
transparency
report confirms
that key
governance
bodies, including
the PIC, receive
KPMG reports that
members of the PIC
and the firm’s
leadership team meet
with investors to
discuss audit-related
matters as well as the
operation of the Code
and the priorities of the
INEs.
Leadership
Values
Management of the
day-to-day activities of
the firm is undertaken
by the Executive
Management Team.
The UK Executive
Board is responsible for
setting the UK strategy
in the context of the
firm’s international
strategy (Mazars being
a global integrated
partnership).
An elected Governance
Council reviews certain
processes and
approves others, It also
ensures that the
Executive Board has
appropriate
management structures
in place and has
identified and is
managing major risks.
Operations
Currently there is no INE
representation on any of the
firm’s other major
committees or
subcommittees although the
PIC meets regularly with the
Audit and Risk Committee.
There is a separate
Public Interest
Committee (PIC)
consisting of the firm’s
INEs.
Mazars
INEs
Mazars’ values are
set out on its
website in a
document called the
“Mazars Way”
The PIC consists of two
INEs. It provides oversight at
a group level and also has
direct engagement with
senior management of the
UK partnership
Reporting
Dialogue
timely and relevant
information to
allow them to fulfil
their duties.
In its transparency report
Mazars sets out its
policies and procedures
under the majority of the
Operations principles.
The firm’s arrangements
around whistleblowing
are set out on their
website
Mazars
transparency
report appears to
cover the
provisions under
the Code’s
Reporting
principle. The
report states that
the UK firm
complies with the
provisions of the
Code in all material
respects.
Mazars reports regular
contact with
institutional investors
and signals its
readiness to engage
with institutional
investors on matters
covered by the Audit
Firm Governance
Code
Financial Reporting Council 21
Leadership
Values
INEs
Operations
Reporting
Dialogue
PwC describes its
values in terms of
quality, ethical
behaviour and a
culture of
partnership with a
strong commercial
focus. The firm
publishes its Code of
Conduct on its
website
PwC has four INEs (there
were previously five but one
resigned when PwC gained
the audit of a company of
which he was Chairman).
They sit on a PIB, together
with representatives from the
Executive and Supervisory
Boards. The PIB meets
quarterly for all day
meetings. INEs form a
majority of the PIB’s
membership.
PwC’s 2014 transparency
report includes detailed
information under each of
Code’s Operations
principles. The Executive
Board confirms the firm’s
compliance with the
provisions of the Code.
All external
disclosures
required under the
Code are made in
PwC’s
transparency
report and/or its
annual report. The
firm reports that its
governance bodies
receive timely and
appropriate
information to
enable them to
discharge their
duties
The firm reported in
2014 that independent
members of the PIB,
along with the Head of
Assurance, had
participated in a
meeting with
representatives from
institutional
shareholder
organisations and had
also met some
shareholder
representatives on an
individual basis
A Public Interest
Committee (PIC) has
been created at group
level to provide
oversight of aspects of
the firm’s management
PwC
PwC describes its
governance structure as
being made up of three
main elements: an
Executive Board
responsible for
developing the policies
and strategies of the
firm and for its direction
and management; a
Supervisory Board
which oversees the
Executive Board and
represents the interests
of the partners; and a
Public Interest Body
(PIB) focusing on the
public interest and
reputational issues.
22 Audit Firm Governance Code: A review of its implementation and operation (May 2015)
Financial Reporting Council
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